Taking advantage of IC-DISC Opportunities

IC-DISC strategy

Most companies can increase their after-tax cash flow by

incorporating an IC-DISC.

After repeal of ETI exclusion, the IC-DISC is the only

option available to obtain export tax benefitsIC-DISC has existed since the '70s and not been challenged by courts or WTO. on dividends.

IC-DISC structure takes advantage of the 15% tax rate

IC-DISC strategy

Shareholder Owned (C or S corporation)

S HA RE HO L DE R
Dividend

S HA RE HO L DE R

Commission Payment

Commission Payment IC-DISC

E X P O RT E R

Servic e s Services

E X P O RT E R

Services s Dividend

IC-DISC

Export Sales

Export Sales

Customer

Customer

IC-DISC benefits

Foreign trading gross receipts Cost of goods sold Gross Margin Selling, general and administrative costs Export sales net income IC-DISC commission (greater of): 50% of export net income 250,000 4% of export gross receipts 400,000 IC-DISC commission Federal tax savings (35%) IC-DISC Dividend Federal tax cost (20%1) IC-DISC net tax savings
1

10,000,000 (8,000,000) 2,000,000 (1,500,000) 500,000

40 0, 00 0 14 0, 000 40 0, 000 ( 80, 00 0) 60,000

Health care tax could cause the rate to increase by 3.8%; and if producer entity is a flow through tax benefit would potentially increase another 4.6%.

OTHER POINTS OF CONSIDERATION REGARDING THE POTENTIAL TAX RATE BENEFITS

DEPENDING UPON THE STATE THE STATE TAX SAVINGS COULD BE SIGNIFICANT. FURTHER, IT IS POSSIBLE THE OBAMA HEALTH CARE TAX OF 3.8% MAY NOT BE APPLICABLE DEPENDING UPON THE OWNERS PARTICULAR CIRCUMSTANCE. IT IS ALSO IMPORTANT TO NOTE THAT THE HIGHEST RATE FOR INDIVIDUALS IS 39.6% SO IF THE PRODUCER OF EXPORT PROPERTY IS A FLOW THROUGH ENTITY FOR TAX PURPOSES THEN THE POTENTIAL BENEFIT IS ALMOST A 20% RATE DIFFERENTIAL.

DISC is exempt from income tax

A DISC is exempt not only from the regular corporate income tax but also is exempt from the minimum tax on tax preferences and the accumulated earnings tax.

Qualifying as a DISC

To qualify as a DISC for a tax year the corporation must meet all of the following requirements for that tax year:
1. Be an eligible corporation 2. Be an actual corporation 3. Meet the q qualified gross receipts test 4. Meet the qualified export assets test 5. Have one class of stock 6. Make a timely election 7. A DISC cannot be a member of a controlled group with a FSC

These corporations cannot be DISCs

The following corporations are not eligible to be treated as a DISC: 1. Tax exempt corporation 2. Personal holding companies 3. Banks and trust companies 4. Insurance companies 5. Regulated investment companies (mutual funds) 6. S corporations

No restriction on who can be a DISC stockholder

The law contains no restrictions on who can be a DISC stockholder. DISC stockholders can include: Corporation Partnership Estate Trust Husband and Wife Tenants in Common Joint Tenants Tenants by the Entirety Minor Foreign Person

Actual corporation

The corporation must be incorporated under the laws of a state (any state) or the District of Columbia. The separate incorporation of a DISC is required by statute, but this does not necessitate in all other respects the sep arate relationship s which otherwise would exist between a parent corporation and its subsidiary.

Qualified gross receipts test

At least 95% of the corporations gross receipts

for the tax year must consist of qualified export receipts.

Qualified export asset test

The adjusted basis of the qualified export assets of the corporation at the close of the tax year must be at least 95% of the sum of the adjusted basis of all assets of the corporation at the close of the tax year.

One class of stock

The corporation must have only one class of stock, and the par or stated value of its outstanding stock must be at least $2,500 on each day of the tax year.

Making timely election to be treated as DISC

The corporation must make a timely election to be treated as a DISC and that election must be in effect for the tax year.

When to elect

For a corporations first tax year, elect within 90 days after the beginning of the year. For any other year, elect during the 90 day period just before the first day of the year the election is to apply.

How to elect

The corporation files Form 4876-A with the service center with which it would file an income tax return if it were subject to income tax. Consents of each person who is a shareholder as of the beginning of the first tax year for which the election is effective are to be or attached to the form.

DISC accounting methods

A DISC generally may choose any permissible method of accounting. But if a DISC is a member of a controlled group it may not choose a method of accounting which would result in a material distortion of the income of the DISC or any other member of the controlled group. These are examples of what IRS considers a material distortion of income:
a DISC uses the cash basis and acts as a commission agent in a substantial volume of sales of property by a related corporation which is on the accrual basis and which customarily pays commissions to the DISC more than two months after the sales. a DISC uses the accrual basis and leases a substantial amount of property from a related corporation on the cash basis, and the DISC customarily accrues any part of the rent more than two months before the rent is paid.

DISC accounting periods

The tax year of a DISC must be the tax year of that shareholder (or group of shareholders with the same 12-month tax year) who has the highest percentage of voting power. If two or more shareholders (or group of shareholders) have the highest percentage of voting power under the above rule, the tax year of the DISC is the same 12month period as that of any such shareholder (or group).

IC-DISC strategy

Calculation of IC-DISC commission income

IC-DISC able to calculate commission income under the following
methods (whichever is greater):

4% of gross receipts method Commission cannot exceed sum of 4% of qualified export - 50% of combined taxable income method
Commission cannot exceed 50% of the combined taxable income of supplier and IC-DISC plus 10% of export promotion expenses IC-DISC's taxable income based on the actual sales price, subject to adjustments under IRC 482 receipts of IC-DISC plus 10% of export promotion expenses

IC-DISC strategy
Qualifications

"Qualified Export Receipts" are receipts from sales of export property

that are manufactured in the US by the supplier and sold for direct consumption or disposition outside the US, or to an unrelated person for delivery outside the US with no more than 50% of the FMV of the property being attributable to articles imported into the US. product to be exported isnt an export sale.

A sale of property to an American manufacturer for incorporation in a "Qualified Export Assets" include A/R arising out of sales in which the
IC-DISC is the principal agent, money, bank deposits, and producer's loans. A producer's loan is a loan of an IC-DISC's accumulated tax deferred profits back to its U.S. parent manufacturing company. The loan amount cannot exceed the amount of the borrower's assets related to its export sales.

Export property as qualified export assets

Export property is any property which meets all three of the following tests:
1. The property must be manufactured, produced, grown or extracted in the US by a person other than a DISC. 2. The property must be held for sale, lease or rental, in the ordinary course of trade or business by, or to, a DISC for direct use, consumption or disposition outside the US. 3. Not more than 50% of the fair market value of the property can be attributable to articles imported in the US.

Whether property is held for export

The destination test (for use, etc., outside the US) is generally considered satisfied if:
1. The DISC delivers the property to a carrier or freight forwarder for delivery outside the US, regardless of the FOB point or place of passage of title, whether to a US or foreign purchaser and whether for use of the purchaser or for resale; or 2. The sale is to an unrelated DISC for such a purpose, whether delivery is to be made in the US or at a foreign destination, or

Rental, etc. of export property

Qualified export t receipts include gross receipts from th e leasing or rental of export property which is used by the lessee of the property outside the US. This includes receipts from subleasing. Whether leased property satisfied the usage test is to be determined on a year-to-year basis. Thus, the receipts on a lease of export property might qualify in some years and not in others depending on the lessees use of property in the year involved. But a de minimus use of the property in the US is permissible.

Services related to the sales and lease of export property Qualified export receipts include gross receipts for services which are both (1) related and (2) subsidi ary to any sal e, exch ange, l ease, rental or other disposition of export property by the corporation. Such services may be performed within or without the US. The DISC need not itself perform the services.

Services related to the sales and lease of export property

l ted servi c i es i nc i l ud de: E xamples of rel a Warranty Maintenance Repair Installation T ransportation, incl uding i nsurance, provide d it s cost t is included in the sale price or rental, or, if separately stated, is p aid by the DISC or itp s p rincip al.

Engineering or architectural services

Qualified export receipts include gross receipts for engineering or architectural services for construction projects located (or proposed for location) outside the U S. These services include feasibility studies and design, engineering and construction supervision. They do not include the provision of technical assistance or know-how or services connected with the exploration for oil.

Qualified export assets defined

Qualified export assets include the following:

1. 2. 3. 4. 5. 6. 7. 8. 9. Export property Export property assets Accounts receivable, etc. Temporary investments of working capital Producers loans Stock or securities in a related foreign export corporation Export-Import Bank and Foreign Credit Insurance Association obligations Export sales finance obligations Temporary bank deposits in US

IC-DISC strategy

Operation of IC-DISC

The ownership of the IC-DISC does not have to mirror the ownership
of the supplier. For example, only one shareholder in a C-Corp. that has 20 shareholders could choose to own the IC-DISC Corp and increase dividend from IC-DISC

Employee/shareholders could choose to reduce their salary from C Commission agreement between supplier and IC-DISC must be
executed with assistance from Counsel

Separate bank account and books and records must be maintained Annual financial statements (I/S & B/S) must be prepared Cash payments must be made from supplier to IC-DISC pursuant to
the commission agreement

The IC-DISC Benefit

An IC-DISC may act as either a buy-sell or commission-based entity. In either case, the income of an IC-DISC is calculated under one of the following: 4% of qualified export receipts, 50% of combined taxable income, or Arm's length amount determined under the p rincip les of Code section 482.

Gross Receipts Method

The qualified gross receipts method allocates 4 percent of the qualified export receipts from export sales to the ICDISC.

This method is used when net margins are less than 8 pe r c e n t .

Example Gross receipts Cost of goods Gross margin Indirect expenses Net income Gross Receipts Method CTI Method IC-DISC Income $10,000,000 6, 0 00 , 0 00 4, 0 00 , 0 00 3, 2 50 , 0 00 750,000 400,000 375,000 400,000

CTI Method

The combined taxable income method allocates 50 percent of the taxable income from export sales to the IC-DISC

Example Gross receipts Cost of goods Gross margin Indirect expenses Net income Gross Receipts Method CTI Method IC-DISC Income $10,000,000 6, 0 00 , 0 00 4, 0 00 , 0 00 3, 0 00 , 0 00 1, 0 00 , 0 00 400,000 500,000 500,000

This method is used when net margins are greater than 8 pe r c e n t .

Code Sec. 482 Method

As a result of limited activities and functions, determining the IC-DISCs income using the transfer pricing principles under Code Sec. 482 generally results in lower income than under the other two methods.

Maximizing the IC-DISC Commission

An exporter can use any of the methods to achieve the greatest IC-DISC income. IC-DISC rules permit the use of different methods to different group s based on product lines, industry or trade usage, or by transaction. Where the net pre-tax margins of export sales are lower than worldwide net pre-tax margins, the exporter may use marginal costing of combined taxable i ncome t t IC -DISC income. to compute

Grouping

Groupings must conform to recognized industry usag ge or SIC/NAICS codes. y use grouping for one May product line and transaction-by-transaction for another product line.

Company

AB

Product Line

Product Line

Transa ction

Transaction

Transaction

GROUPING EXAMPLE

Example Base Case Gross receipts Cost of goods Gross margin Indirect expenses Net income Gross Receipts Method CTI Method IC-DISC Income $10,000,000 6, 0 00 , 0 00 4, 0 00 , 0 00 3, 0 00 , 0 00 1,000,000 400,000 500,000 500,000 Product A 5,000,000 4, 0 00 , 0 00 1, 0 00 , 0 00 750,000 250,000 20 0, 0 0 0 12 5, 0 0 0 200,000 Product B 5,000,000 2, 0 00 , 0 00 3, 0 00 , 0 00 2, 2 50 , 0 00 750,000 2 00 , 00 0 3 75 , 00 0 375,000

Marginal Costing

If the profit margin on export sales is less than the profit margin on worldwide sales of the same product, the marginal costing rules may be applied to allocate only marginal or variable costs against export receipts. Overall profit percentage limitation (OPP) limits export CTI to full costing CTI from all sales (foreign and domestic).

Marginal Costing Example

Example Total Sales Gross receipts Cost of goods Marginal Costing CTI Indirect expenses Full Costing CTI MC Profit M argi n OPP MC CTI (Limited to OPP) IC-DISC Income 20% 1,000,000 500,000 $10,000,000 6,000,000 4,000,000 2,000,000 2,000,000 Export 5,000,000 3,500,000 1,500,000 750,000 750,000 30% Domestic 5,000,000 2,500,000 2,500,000 1,250,000 1,250,000

Expense Allocation and Apportionment

When using the CTI method, overhead costs are generall y allocated between exp ort and domestic sales, based on the rules under Treasury Reg. Sec. 1.861-8.

Transaction-by-Transaction

The pricing method chosen is required on a transaction-by-transaction basis ; however , an annual election can be made to group transactions in accordance with products or product lines. Neither the gross receipts nor CTI method may be applied in a way that causes, in any taxable year, a loss the U.S. exporter (related supplier).

Documentation

Source Data (Sales and Cost of Sales) Support Product Hierarchy and Support Expense Allocation & Apportionment Methodology Transactional Analysis Qualified Export Sales (U.S. Manufactured, NonU.S. Destination and 50% Content) Pricing Method Reports Form 1120-IC-DISC

Advanced Topics

Roth IRA Executive Compensation Sourcing (Passive) Transaction-by-Transaction Producer's Loans IC-DISC and 863(b) Shared DISCs

Executive Compensation

IC-DISC ownership is set up through key employees.

Employee

Owner

IC-DISC

Commission

C-Corp

Sourcing Benefits

IC-DISC dividends are considered foreign sourced income to U.S. owners IC-DISC dividends are categorized into the passive bas ket Can use IC-DISC to increase the ability to utilize tax credits in the passive basket Title passage FISC income

Transaction-by-Transaction

May significantly increase IC-DISC benefit gg gate Compared to ag g reg Requires advanced software applications Iteration of alternative groupings and marginal costing analyses

Rede termiinatti ion of open years Documentation

Producer's Loans

Producer's loans are a category of qualified export assets which permits a DISC to loan its tax deferred profits back to its parent manufacturing g comp pany ( or any other U.S. exp ort manufacturing corporation). The borrower must increase its inventory, plant, etc. by an amount equal to the loan by the end of the year of the loan. These producer's loans are qualified export assets and the interest of these loans constitutes qualified export receipts. The loan is designated as a "producer's loan" within the meaning of IRC s. 993(d) at the time of the loan.

IC-DISC and 863(b) Sales

Use of IC-DISC does not preclude use of Section 863(b) to increase foreign source income Can claim IC-DISC benefit on 863(b) sales May be required to allocate/apportion IC-DISC commission to foreign source income under Section 861